What do insurers invest in

All of that money in premiums generates a lot of money for insurance companies. The companies don't have to pay out any money until or unless an insurance claim is submitted, such as a claim for a hospital visit or damage to a home during a tornado. What do insurers do with the often huge sums of cash generated by premium payments? The companies put some aside in reserve to ensure that they'll have enough to pay all claims anticipated over the near term.

But then they invest the rest of the money. Investment income tends to be a lot smaller than underwriting revenue. Many insurers invest relatively conservatively, perhaps by investing in bonds or stable blue chip stocks. However, insurance companies can still significantly pad their top and bottom lines through their investments. There are two primary reasons why you might want to consider investing in insurance stocks.

First, insurance companies can deliver solid long-term returns. Second, the business models of insurers tend to make them resilient during economic downturns. Of course, some insurance companies are better than others on both of these fronts.

Insurance stocks are usually seen as good picks for conservative investors. Property and casualty insurance companies usually invest around 30 percent of holdings in common stocks. The appeal of bonds is that they provide a much more predictable future cashflow, but also investment grade bonds return markedly less on average than the long-term return of the stock market.

By investing only a portion of their premiums in the riskier stock market, they still participate to some extent in its higher returns, but without assuming the full risk of the stock market's volatility. But there's one more reason for insurance companies to invest in both stocks and bonds rather than bonds alone: the two investment classes are only weakly correlated.

They tend to rise and fall somewhat loosely together, but not exactly. Nevertheless, there is some correlation. An ideal third investment choice for insurance companies would be another relatively low risk that's uncorrelated — in other words, an investment whose returns are independent. In fact, investment in the mortgage market, which is relatively uncorrelated, accomplishes just that. The life insurance sector of the insurance market invests about 15 percent of its premiums in mortgages and first liens.

These three asset classes — bonds, stocks and mortgage instruments — comprise about 90 percent of investments for life insurance companies and over 80 percent of investments for property and casualty insurers.

The analysis identifies the major asset categories so as to facilitate comparisons among the selected markets. A distinction has been made, whenever possible, between the traditional portfolio in which the insurance company holds the investment risk and the unit-linked portfolio in which it is the person taking out the insurance who assumes the investment risk.

It is the composition of the traditional portfolio that presents the greater interest for purposes of analysis, since in the latter case, the investment decisions and the risk assumed fall to a great extent on the person taking out the insurance.

In Table 1 , the differing volumes of the markets analyzed can be observed, while Table 2 shows the respective proportions of traditional and unit-linked business. The combined value of the investment portfolios analyzed totals The analysis conducted examines the structure of the portfolios and also assesses how they have changed over the last decade.

In the Eurozone , for example, unit-linked business represented Most insurance companies generate revenue in two ways: Charging premiums in exchange for insurance coverage, then reinvesting those premiums into other interest-generating assets.

Like all private businesses , insurance companies try to market effectively and minimize administrative costs. Revenue model specifics vary among health insurance companies, property insurance companies, and financial guarantors. The first task of any insurer, however, is to price risk and charge a premium for assuming it.

It needs to assess how likely a prospective buyer is to trigger the conditional payment and extend that risk based on the length of the policy. This is where insurance underwriting is critical. Without good underwriting, the insurance company would charge some customers too much and others too little for assuming risk. This could price out the least risky customers, eventually causing rates to increase even further.

If a company prices its risk effectively, it should bring in more revenue in premiums than it spends on conditional payouts. In a sense, an insurer's real product is insurance claims. When a customer files a claim, the company must process it, check it for accuracy, and submit payment. This adjusting process is necessary to filter out fraudulent claims and minimize the risk of loss to the company. It could hold onto the money in cash or place it into a savings account , but that is not very efficient: At the very least, those savings are going to be exposed to inflation risk.

Instead, the company can find safe, short-term assets to invest its funds. This generates additional interest revenue for the company while it waits for possible payouts. Common instruments of this type include Treasury bonds , high-grade corporate bonds , and interest-bearing cash equivalents. Some companies engage in reinsurance to reduce risk. Reinsurance is insurance that insurance companies buy to protect themselves from excessive losses due to high exposure.

Reinsurance is an integral component of insurance companies' efforts to keep themselves solvent and to avoid default due to payouts, and regulators mandate it for companies of a certain size and type.

For example, an insurance company may write too much hurricane insurance, based on models that show low chances of a hurricane inflicting a geographic area.